As Gevo reports its 4Q results and adds back some ethanol production, we look at the short-term gains and the long-term implications.

This week, Gevo reported its year-end results, generally in line with expectations, with a $0.35 loss per share and $24.6M in the bank. Given the company’s rate of progress with isobutanol, the cash burn rate, the low share price, and high prices for ethanol — the company announced that it is “transitioning the Luverne plant to the production of both isobutanol and ethanol…Producing both ethanol and isobutanol allows Gevo to fully utilize the Luverne plant and increase cash flow as Gevo continues to commercialize its isobutanol production capabilities.”

“Our original vision was to focus our efforts on one product,” said CEO Pat Gruber. “However we now are confident that we can leverage the flexibility of our technology and more fully utilize all the operating units in the plant to produce ethanol simultaneously with isobutanol. Needless to say, the expected additional cash flow is a benefit as we work to maximize the learning per dollar as we scale up our technology.

“Therefore, we plan to run three of our fermenters to produce ethanol, while the fourth fermenter will remain dedicated to isobutanol production. We are calling this configuration “side by side”, meaning both ethanol and isobutanol could be produced concurrently.

Analyst reaction

Rob Stone and James Medvedeff, Cowen & Co:

The economics now favor, and the science now enables, concurrent production of isobutanol and ethanol at Luverne. However, we believe ramping to full nameplate, regardless of configuration, is still at least several quarters away.

Luverne is shifting to concurrent production of ethanol and isobutanol, to take advantage of current wide ethanol spreads. The initial mix will be three fermenters producing ethanol, one producing isobutanol. We believe this demonstrates the flexibility of the GEVO technology, and highlights successful isolation and eradication of sources of infection. It may have been influential in attracting the two licensing LOIs signed since October. Important side benefits include more stable flows of corn mash, water recycling, and solids removal (animal feed) from the plant, the opportunity to optimize operations at higher production rates, and reduced cash burn.

Mike Ritzenthaler, Piper Jaffray

The decision to produce ethanol ‘side-by-side’ with increasing isobutanol production rates will be controversial – but ultimately we view as a positive for cash (with spot ethanol EBITDA margins >$1/gallon) and provides more stable operating parameters. This will further aid isobutanol optimization efforts that have seen ~71% of target gallons per batch and a lift to 1-2 batches per week on average (from 1-2 batches per month in December). We are adjusting our estimates due to incremental ethanol sales that we did not previously factor into our model.

We expect ethanol production to start in mid-May and reach a 15k gallon/year run-rate starting in 3Q13, resulting in FY2014 Sales of $45 million. Ultimately, however, we see ethanol production at Luverne tailing off in 1H15 as isobutanol continues to ramp. This results in FY14E revenues of $45.4 million (from $14.5 million) and ($20.7) million in EBITDA, from ($36.5) million previously.

This should make the technology package more attractive to potential licensors while investors should welcome the cash flow attributes of ethanol production as isobutanol production ramps, in our view. Our price target is based on 5x our FY15 EBITDA estimate (from FY15 EBITDA discounted to 2014), with $0 million in net debt and 49 million shares.

Progress with the Process

Gevo reported in this cycle the following process improvements:

• Commissioned a proprietary system to sterilize corn mash.
• Proven that its two key technologies, our isobutanol producing yeast and our GIFT system, work at commercial scale utilizing full corn mash to produce isobutanol.
• Achieved up to 71% of our targeted gallons per batch goal.
• Produced isobutanol that met quality targets.
• Demonstrated that the company can manage infections during fermentation, achieving over 100% of goal, although not with the consistency or reliability that we need.
• Operated all of the fermenters and GIFT systems and they performed as expected.
• Begun the integration of the water recycle streams, and achieved greater that 90% water recycle in fermentation.

The Licensing Option

On March 6, 2014, Gevo announced that Porta Hnos signed a letter of intent to become the exclusive licensee of GIFT in Argentina to produce renewable isobutanol. Porta is a 131 year old family owned company in Argentina that produces liquor, vinegars and has a 120 m3/day corn ethanol plant (approximately 12mgpy).

In addition, Porta has designed and built two 250 m3/day ethanol plants for others and they are working on two more ethanol plants for 2014. Half of all current ethanol plants in Argentina were designed by Porta, and they have a joint venture with Alpha Laval to provide separation and evaporation expertise.

Offtake and testing: the Q4 highlight reel

In Q4 2013, Gevo began selling bio-isooctane for specialty fuel applications such as racing fuel. Gevo’s renewable isobutanol from Luverne, Minn. is being converted into bio-isooctane at its biorefinery at South Hampton Resources. Initial volumes are being used for testing purposes.

Also in Q4 2013, the U.S. Army has successfully flew the Sikorsky UH-60 Black Hawk helicopter on a 50/50 blend of Gevo’s ATJ-8 (Alcohol-to-Jet). This testing is being performed as part of the previously announced contract with Gevo to supply more than 16,000 gallons to the U.S. Army. Gevo’s patented ATJ fuel is designed to be the same as petroleum jet fuel, and to be fully compliant with aviation fuel specifications and provide equal performance, including fit-for-purpose properties.

In December, Gevo announced that Underwriter Laboratories approved the use of up to 16% isobutanol in UL 87A pumps, providing all of the service stations across the country with the assurance that isobutanol blended gasoline will work in their current gasoline pumps without the need to purchase new equipment.

The Move to Ethanol

Let’s be frank about this — for a long time, Gevo has taken a dim view of the first generation biofuels it now proposes to produce. “1st generation biofuels created conflict,” the company noted earlier, citing that refiners lose volume, pipeline companies lose volume, customers get lower energy fuel and ethanol producers struggle with the blend wall, with the push for ethanol causing more conflict.”

The company switched “back to ethanol” once before, in fall 2012, at the time its contamination difficulties were becoming more apparent at scale. “Gevo has successfully demonstrated commercial scale isobutanol production, has navigated idiosyncratic biocatalyst challenges in past scale-ups, and elected to utilize the Luverne asset while the contamination controls are optimized,” Piper Jaffray analyst Mike Ritzenthaler wrote in 2012. Adding, that “the biologists are working to improve the production strain and fermentation parameters to enable better control of competing reactions, a process that in our experience will take a handful of months at most to optimize.”

“The switch to ethanol does not reflect any change in strategy,” Ritzenthaler added. “Management is electing to operate the facility rather than conduct the strain improvement at such a large-scale.”

Having noted all that, Gevo have been consistent in touting the “carbohydrate market” and superior US productivity in this regard, compared to the oil market — as much or more as they have waded into the ethanol-or-isobutanol question.

Doubtless, given normal price environments and steady-state operations in ethnaol and isobutanol, they would generally produce isobutanol. The switch to ethanol reflects the “Market opportunity driven by the spread between carbohydrate and oil” as they have detailed in many presentations. With oil topping $100 and corn sub-$5, Gevo is clearly seeing that the time to produce alcohols is now — and if isobutanol is not yet ready for immediate scale-up, the other alcohol will do nicely.

But there’s a caveat in their strategy. Spreads are high, but they vary, and often quickly. CEO Pat Gruber has been out front with the industry on warming about the dangers of selling the “same” molecule with the “same” price and performance, as this slide illustrates.

Further to that point, one has to consider how much damage has piled up on the Gevo “brand” over the past two years, with the well-publicized difficulties in getting to full production at Luverne — while discussions of a conversion at Redfield seem to have pushed off into the distance. On the potential for selling into markets with a damaged brand, Gruber was stark in his assessment, here:

Gevo’s legion of admirers will be quick to point out that the company’s struggles are not untypical for introducing first-of-kind technology, and they are temporary in nature — causing delays rather than failure — and that the brand of the company is strong with partners like Coca-Cola and the US Army. With a strong brand, Gruber took the view that even a “same” product at the “same” price and performance could have very strong sales prospects, here.

The delays with isobutanol

The delays have been, for its investors and stakeholders, frustrating to say the least. Two years ago, the company was “on track for isobutanol production in 2012″ and expected to be bringing Redfield online in 2013.

We didn’t hear much back then about the time delays associated “Learning to run a ‘new-to-the-world’ process at the scale of our Luverne plant with 1 million liter fermenters requires a lot of work. Working through the issues that arise creates the crucial know-how needed for steady full scale production, expansion, and licensing,” as Gevo reflected on its progress in its latest update.

The company’s strong management team — especailly in managing start-ups with first-of-kind-technology — caused many to underestimate the challenges of scaling this technology. “While every novel process startup contains some uncertainties, we believe Gevo has an outstanding team in place with the optimal expertise needed to understand and mitigate risks – and meet or exceed important production milestones between now and the end of the year,”

Piper Jaffray analyst Mike Ritzenthaler wrote in May 2012. He added in July: “Based on our background and observations, we believe startup is proceeding remarkably well, and we are confident that Gevo’s team can quickly handle normal startup issues, should they arise.”

The biojet options

The company’s struggles with isobutanol have to some extent overshadowed its successes with biojet fuel — passing Army tests with flying colors, and proceeding rapidly towards an adoption of an approved ATJ (alcohol to jet) fuel spec in the not-distant future. The company’s South Hampton demonstration plant has been supporting those efforts.

The isobutanol option

The company would like to produce all-isobutanol no doubt about it: as Pat Gruber pointed out, “isobutanol and its derivatives can serve multiple large markets.” But here’s the caveat, he warned in 2013: “low cost isobutanol is the enabler,” and frankly, Gevo’s yields and throughput is keeping its isobutanol out of all those juicy verticals.

The Bottom Line: the vital importance of getting back to isobutanol

Let’s be clear about restating this: Gevo has never spun a story about a “single molecule” strategy. But they simply have not showcased their ethanol capabilities in this respect. Ethanol has been a sub-optimal fallback. They’ve been much more excited about opportunities with isobutene and renewable jet fuel, for example.

As we outlined in the Bioenergy Project of the Future series, staring with a first-generation ethanol plant is a great idea. Stating with that technology a while while other technologies are introduced: that’s fine, for a while, But falling back on first-generation fermentation is not a demonstration of production flexibility, in a 19 million gallon facility that is unlikely to be able to compete with the likes of POET and its fleet of 100 million gallons plants, based on economies of scale.

So, this is a temporary move, based around cash conservation, aimed according to analyst estimates at improving EBITDA by an estimated $15.8M in 2014. Coincidentally, about the same amount of capital the company parted with in early 2013 in a $15M share buy-back program. The company also takes the view that it helps to solidify its licensing story, by giving licensees a side-by-side production opportunity in isobutanol and ethanol.

We’re a little skeptical, here in Digestville, about the long-term value of that strategy. Short-term, while the company works through what is proving to be a 3-year scale-up effort, it makes sense. Should ethanol prices hold up, it will certainly help with earnings and cash – though it will tie-up talent, working capital, and divert the focus to some extent. We’ll see shortly how Gevo navigates those waters — as it continues to make steady, if slow, progress towards its game-changing isobutanol ambitions.